The Irish government today signalled a tentative recovery in its banking sector after it agreed to support the re-financing of Bank of Ireland as part of a €3.4bn (£2.9bn) fund-raising package.

Ministers agreed to swap preference shares worth €2bn for ordinary shares in the bank in a move that allows Bank of Ireland to comply with European union capital rules. Finance Minister Brian Lenihan said the plan, which will also raise funds from private investors, had avoided the government putting any extra money into the bank.

Bank of Ireland said it wanted to develop a separate business in Britain with its own board and under the supervision of the Financial Services Authority as it sought to establish its brand after a disastrous two years when it almost went bust.

Without mentioning Greece, Lenihan said Ireland, which owns 36.5% of Bank of Ireland, was tackling its legacy of reckless lending and putting its banks on a sound footing.

He said: "The level of private sector investment is tangible evidence of the growing international and domestic confidence in both Bank of Ireland and our economy. I have stressed on numerous occasions that others have confidence in us and we need to demonstrate that confidence in ourselves. Today's announcement shows that Ireland can and is addressing the difficulties in our financial sector."

Last year Ireland came close to a Greek-style meltdown before it separated billions of pounds of toxic bank debts into the National Asset Management Agency (NAMA), Ireland's "bad bank".

The deal was hugely controversial after ministers were accused of overpaying for the assets.

The financial regulator told Bank of Ireland last month to raise €2.7bn to meet new minimum capital requirements and compensate for losses on discounted loans sold to NAMA.

The bank, which is also selling its life assurance unit to satisfy EU demands for state aid, last week listed the four ways it planned to raise capital but it did not at that time provide any figures.

Last year's injections to keep nationalised Anglo Irish Bank afloat alone cost €4bn, giving Ireland the highest budget deficit in the European Union compared with the size of the economy, and much more state aid is on its way.